Joel Greenblatt has proposed a stock screen for which he has reported enviable results. He reported an annual 30.8% return for his “Magic Formula” in his book, “The Little Book that Beats the Market.” Since publishing his book, his strategy has performed well, though many analysts who have followed the “Magic Formula” have not seen 30.8% annual returns, but have seen outperformance from this strategy. His results are particularly interesting because his picks are not subjective: they are based on a simple ranking of earnings yield (EBIT/EV) and return on capital.

Though I am not yet a proponent of this investment strategy, I am interested in how it works and how a “Magic Formula” allocation could fit into an investor’s portfolio. Historically, this strategy results in a beta of roughly 1 (1.05) and a blend of value and growth. Since there is no value tilt, a portfolio based on the “Magic Formula” could have the potential to be an investor’s core holding.

How rapidly are the Magic Formula stocks added to and dropped from the list? In order to kick the tires, I wanted to see how the list of top 50 Magic Formula stocks changes week over week. I generated the portfolio on 8.22.2011 and every week since, through 9.20.2011. Of the 50 magic portfolio stocks, 12 have been dropped from the list, 10 have been added, including 1 that had been dropped has returned to the list:

These changes have had very small impacts on the portfolio’s overall attributes. The mean price to earnings ratio has increased from 8.47 to 8.92, the mean price to book ratio has decreased from 3.30 to 3.26, and the mean beta has decreased from 1.34 to 1.24.

This study will continue weekly to observe the number of stocks that are added or taken from this portfolio. Changes could depend on various factors including broad market volatility, quarterly reports, or macro events. Time will tell.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.